Chapter 3 Market Equilibrium



bulletLearning Objectives
bulletKey Terms

Learning Objectives

bulletUnderstand how demand and supply determine market equilibrium
bulletExplain how the market adjusts to equilibrium given either excess supply or excess demand
bulletGiven a shift in demand or supply indicate the change in equilibrium price and quantity

     By the end of this chapter you should have a basic understanding of the most important instrument in the economist's toolkit.

     Coming together, like blades of scissors, demand and supply determine market equilibrium. At market equilibrium the quantity that consumers freely and willingly demand at the market price is exactly equal to the quantity that producers freely and willingly bring to market at that price. There is neither excess demand (shortage) or excess supply (glut) on the market.

     What is bought in a market must be equal to what is sold. This is a truism that must hold. Market equilibrium means more that. It indicates that the amount consumers want to buy at the market price is exactly equal to what producers want to sell at the same market price.

     It is important that you understand the concept of equilibrium in economics. Equilibrium is neither intrinsically good nor bad. An equilibrium exists when opposing forces just offset each other. Consequently, if an economy or a market is at equilibrium it will tend to stay there. Typical, equilibria in economics are stable equilibria, meaning that if the system is in disequilibrium there are forces that tend to push it back to equilibrium.

     If a goods market is in disequilibrium, price should be either rising or falling. When the quantity demanded exceeds the quantity supplied there will be excess demand and the market price will rise. It is the rise in the price that then eliminates the excess demand and brings the quantity demanded into equality with the quantity supplied. As market price rises the quantity demanded decreases as consumers substitute other goods for this one. In addition, as market price rises producers decide to bring additional quantities to market. These processes will continue until the excess demand is eliminated.

     When the quantity supplied exceeds the quantity demanded, then there will be excess supply in the market. At the current market price, some suppliers will be unable to sell all of there output. This should put downward pressure on market price. Price should continue to fall until the excess supply is eliminated and the quantity demand exactly equals the quantity supplied.

     If you are unsure about these concepts you can try a short quiz at the University of Omaha by Kim Sosin.

bulletSelf-test on Demand and Supply

Key Terms

bulletequilibrium price
bulletequilibrium quantity
bulletexcess demand
bulletexcess supply
bulletmarket equilibrium



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Ralph R. Frasca, Ph.D. 2007